A windfall of natural resources (or aid) faces government with choices of
how to manage public debt, investment and the distribution of funds for
consumption. The permanent income hypothesis suggests a sustained increase
in consumption supported, once resources are depleted, by interest on
accumulated foreign assets. However, this strategy is not optimal for
capital-scarce developing economies. Incremental consumption should be
skewed towards present generations. Savings should be directed to
accumulation of domestic private and public capital rather than foreign
assets. Optimal policy depends on the impact of distortionary taxation and
ability of consumers to borrow against future revenues.
